Wednesday, September 7, 2011

These charts help us appreciate just how painful the sovereign debt crisis has been for Europe: Eurozone stocks have underperformed U.S. stocks by almost 30% since the beginning of last year.

It was shortly after the beginning of 2010 that the world began to realize that Greece was in a world of hurt. Greek 2-yr bond yields stood at 3.4% when 2010 got underway, about 200 bps above German 2-yr yields of 1.3%, reflecting a modest degree of caution on the part of investors. By early May 2010, however, that spread had blown out to almost 1800 bps as investors began speculating that a Greek default was becoming likely. Things settled down briefly as other Eurozone countries came to the rescue, but then began to heat up again, culminating in today's spread of a nearly catastrophic 5400 bps.

The top chart above compares the total return on the S&P 500 index (green line) with the total return on the Euro Stoxx 50 index (white line), beginning at the end of 2006 through early this month, on a weekly basis. It should be clear that the two markets were moving almost in lockstep through the end of 2009. The second chart compares the same two indices beginning at the end of 2009 through today, on a daily basis. Here we can see how the performance gap opened up briefly in the first half of last year as the Greek crisis took center stage, and then started widening progressively from the end of August 2010 through today.

To date, the Eurozone's strategy to cope with the sovereign debt crisis has mainly consisted of efforts to spread the cost of a bailout among all the countries, and it shows, because the sovereign debt crisis is acting like a ball and chain on all of Europe. The current market capitalization of Eurozone stocks is roughly $4.5 trillion; if the Eurozone market had continued to track the performance of the U.S. market, that market cap would be $6.3 trillion today. In other words, the cost of the sovereign debt crisis for Europe has been a staggering $1.8 trillion dollars (and probably much more, since without the eurozone crisis U.S. stocks would likely be trading at substantially higher levels today).